Software’s Temperamental Star

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Tom Kelly is a believer. The CFO and chief information officer of Kardia Health Systems has seen big savings from the technology known as “software as a service,” or SaaS. Kelly has migrated nearly all of his company’s traditional business applications to these Web-enabled solutions that are usually priced in a subscription model and typically cost $10 to $50 per user per month.

Kelly says the SaaS model helps him do more with less. As one example: “What we used to pay for five people’s use of a traditional accounting software package now buys us not only financials but also dashboards, CRM, and e-commerce. There’s just no comparison.”

He loves being able to log on to the SaaS offering (from NetSuite) from anywhere, and welcomes the fact that the monthly price includes maintenance, support, and even hardware (on NetSuite’s end). In fact, Kelly has now embraced SaaS offerings from other vendors, including Google, Salesforce.com, and Adaptive Planning.

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But even an evangelist like Kelly admits that SaaS still has kinks to be worked out. “SaaS is growing so fast that you sometimes get salespeople who don’t know what the product can and can’t do, and what it can and can’t be integrated with,” he complains. “So they promise something that can’t be delivered. That leaves a bad taste in your mouth.”

More CFOs are finding themselves in Kelly’s shoes. SaaS debuted a decade ago but has only recently become the software industry’s shining star, goosed by tight capex budgets, frustrations with high software-maintenance fees, and the hype over “cloud computing,” in which Internet services replace (or try to) traditional shrink-wrapped software.

SaaS offerings now account for 9% of the business-software market, and sales are growing at a 20% annual clip. Gartner predicts that by 2013 SaaS will command a 15% to 16% market share. Yet Gartner also says that only a minority of users expressed an interest in expanding their use of SaaS alternatives, and a small percentage (5%) planned to discontinue it, according to a survey conducted in December 2008.

Integration is the top source of dissatisfaction. “There has been a lot of concern around a large number of SaaS offerings coming out that don’t have effective application programming interfaces” to facilitate connection to other programs, says Treb Ryan, CEO of OpSource, a provider of integration solutions to SaaS vendors.

Ryan says the good news is that this lack has created a booming market for third-party integration offerings, which have become more robust in the past several years. Vendors such as Boomi and Cast Iron can smooth over holes left by SaaS vendors.

Armed with an awareness of this pitfall, more clients are now pushing for flexible cost arrangements that compensate them for integration delays. Joe Zulich, senior business analyst at White-Rodgers, a division of Emerson Electric, oversaw a move to an accounts-payable SaaS offering from DataServ that took longer than expected. “You will probably spend more than you expect to on programming, so negotiate fees up front to allow for unforeseen changes,” advises Zulich. “Work with a company that’s very flexible and understands you’re going to run into problems and won’t nickel-and-dime you to death.”

Your Costs May Vary

Although a huge part of the SaaS pitch is its cost-effectiveness, cost turns out to be the second most commonly cited source of dissatisfaction, according to Gartner. “People are realizing that all these promises of dramatically reduced expenses are not necessarily coming to fruition,” says Gartner analyst Robert DeSisto. “Clearly it looks good in the first couple of years, because you don’t have a big capex outlay, but in subsequent years CFOs find themselves asking, ‘Where are the true savings? Where is the reduction in head count, in infrastructure?'”

To be sure, many companies do save money, especially small and midsize businesses with limited IT resources. Doug Menefee is CIO at Schumacher Group, a 750-person firm that provides emergency-department management services to hospitals. He had moved half of his applications to SaaS by the beginning of 2009 and saw a savings equivalent to the salaries of four full-time employees. He plans to migrate another 25% of his software to SaaS by the end of the year.

But Doug Tracy, CIO of auto- parts maker Dana Holdings, which has 22,500 employees, has had different results. “With SaaS you don’t necessarily get better ROI, you just tend to get the solution faster,” he says. “In some cases it can be a better ROI because the payback is quicker, but it’s not necessarily a lower-cost solution.”

Tracy is also cautious about data-integration issues and the lack of control over upgrades with SaaS solutions. “I’m less apt to be concerned about support for older applications,” he says, “because problems have been patched and my staff can take it from there, so we’re looking at canceling the support and maintenance on a lot of the old software. But if you go with a SaaS approach, that option isn’t available to you, because the support is bundled in.”

Fee Folly

SaaS pricing is another area where companies need to proceed carefully, because the models have changed over time and may not be as flexible as customers expect. In some cases, in fact, the model has swung completely around to mimic the traditional site license. For some customers that’s fine. “We said we wanted to give every employee a license and we got a multi-year contract that we paid up front,” says Schumacher’s Menefee. “That gave us predictability on what our spend rate would be.”

But others have worked to keep terms more flexible. Kardia’s Kelly tries to negotiate payments and an option to change the number of licenses on a quarterly basis. Smaller vendors are more likely to go for the latter, a helpful provision during the recession. When Kelly’s former employer, exercise-equipment dealer Second Wind, was forced to shut 10% of its retail outlets and lay off store managers, its automated work-order and maintenance-tracking software provider, WorkOasis, allowed Second Wind to reduce its number of licenses accordingly. Similarly, DataServ says that some of its customers have been relieved to learn that the software can scale down as well as up.

That’s the kind of flexibility that has won Kelly over. He and other SaaS enthusiasts also point out that early fears about security and reliability have largely been dispelled. “If these guys don’t provide security and guaranteed uptime, they’re dead in the water,” he says.

Many SaaS vendors have worked hard to answer complaints about customizability, too. The latest platforms allow at least some modifications.

While those advances have further galvanized the SaaS model, allowing it to outlive an earlier cousin, the “application service provider,” it still has its work cut out for it if it is to become the panacea its marketers like to claim it is. The big question for SaaS may be this: Will it propel the concept of cloud computing, or merely ride its coattails?

Yasmin Ghahremani writes about business and technology.

7 Steps to Savvier SaaS

Five years ago SaaS (software-as-a-service) contracts were barely glanced at by business units, but today they are often scrutinized by IT or legal for all kinds of issues. Despite the fact that customers are wiser, a recent Burton Group-Ziff-Davis Enterprise survey found that 23% of organizations admitted to having no SaaS controls at all, and many fail to negotiate nonmonetary terms of standard contracts. Kerry Kane, a principal at Software Contract Solutions, offers this advice on what to look for when negotiating a SaaS contract:

1. Make sure you choose the right vendor, because switching vendors can be costly. It’s often expensive to migrate off a platform, and while you shop for a new vendor you will have to keep paying the old one. Drive a hard bargain up front, because the vendor will be much less likely to negotiate good terms upon renewal.

2. Find out how the vendor will help you retrieve your data if the arrangement should end for any reason, and make sure you will get the data in a usable format.

3. Be realistic with the number of seats you commit to and the deployment time frame. Ask for a ramp-up period and flexibility for adding users. For example, secure no cost for the first three months while the application is being rolled out. Kane also suggests putting a pricing table in the contract so you can negotiate up front for different price schemes should the number of users change.

4. Ask about data protection: Who is doing backups? Where is data being stored? Is the code being held in an escrow account in case the vendor fails?

5. Make sure service-level agreements (SLAs) are clearly defined, with penalties stated for failure to meet them. Try to get the availability component of the SLA negotiated for the shortest time period possible; for example, monthly or quarterly as opposed to annually. The vendor, for instance, might have to provide 99% uptime, with the customer given the right to cancel if the vendor fails to meet that level in two consecutive months.

6. Incorporate change-of-control language into the contract to make sure that if the vendor is acquired you have an option to lock in renewal rates at your current rates for 12 or 24 months, while you decide whether you want to stay with the new vendor. Protect yourself from annual price increases, as well. Standard renewal rates should not exceed 3% or the CPI, whichever is less. Finally, make sure you have the ability — at no cost — to assign or transfer your contract if your own company is acquired or merged.

7. Consider using an experienced contract consultant who can assist in achieving best-in-market pricing, terms, and conditions. Most firms are not affiliated with the vendor community, will negotiate directly with your vendor account team, and will offer a no-risk performance model, where fees are based on a percentage of money saved.